How will high inflation and rising rates affect the world’s growing debt mountain? A fundamental question that must be taken into account from now on.
During the past years, this issue was not often raised or put under the spotlight, as is the case today with regard to inflation. The reason is simple. Decreasing interest rates and inflation for decades have kept borrowers’ service costs low.
But that will definitely change today after the release of eye-catching global debt data, just like inflation.
A recent report by JPMorgan starkly details the scale of the problem. It indicates that the total global debt amounted to 352 percent of GDP in the first quarter of this year, with private sector debt accounting for two-thirds of this debt, and one-third is attributed to public sector debt.
In a report by the Institute of International Finance, global debt reached $303 trillion in Q1 2022, a new record high.
And the International Monetary Fund said in the latest update of its database that public debt rose in 2020 by 28 percentage points to 256 percent of GDP.
The head of the International Monetary Fund, Kristalina Georgieva, warned a few days ago of the dangers of the growing scourge of high debt and stressed that there is a need for strong global leadership in order to deal with it.
In the IMF figures, more than 30 percent of emerging and developing countries have reached the debt crisis stage or are close to reaching it. For low-income countries, this percentage is as high as 60 percent.
Last December, the IMF published a report that showed that the world witnessed a rise in debt in 2020 during the largest boom year since World War II, as global debt reached $226 trillion dollars before the world hit a global health crisis (COVID-19) and led to a state of a deep recession.
Debt was already high in the pre-pandemic period, but governments now must navigate a world characterized by record levels of global public and private debt, new mutated strains of the virus, and a continuing rise in inflation, according to the IMF report.
“With tighter financial conditions and lower exchange rates, the debt servicing burden has become severe – and unsustainable for some countries,” Georgieva said. She urged the G-20 to turn over its previous pledges to contribute to the establishment of the Trust Fund for Resilience and Sustainability, approved last year, worth $40 billion so that it becomes effective by the annual meetings next October.
High interest
Low debt servicing costs have until recently allayed fears that the public debt of advanced economies would rise to record levels. This is due to two components:
The first is the very low nominal interest rates. In fact, their levels were close to zero or even negative along the yield curve in countries such as Germany, Japan, and Switzerland.
Second, neutral real interest rates have been significantly downward in many economies, including the United States, the eurozone, and Japan, as well as in a number of emerging markets.
But the tightening policies adopted by central banks all over the world by raising interest rates have a great repercussion on governments, companies, and even families, which will have to borrow at higher rates. This may lead many countries to declare their failure to pay their obligations.
In this context, rating agency Fitch predicted at the beginning of this month that a new wave of countries could be defaulting due to the war in Ukraine, which is causing the sovereign borrowing costs to rise. It attributed the increased borrowing to most governments having to increase subsidies or reduce taxes to reduce the impact of inflation. It added that higher interest rates would increase government debt servicing costs.
The number of countries in the list of countries that are in default – or whose bond yields in the financial markets indicate that this has happened – is 17, which is a record level.
These countries are Pakistan, Sri Lanka, Zambia, Lebanon, Tunisia, Ghana, Ethiopia, Ukraine, Tajikistan, El Salvador, Suriname, Ecuador, Belize, Argentina, Russia, Belarus and Venezuela.
Emerging markets debt
There is a need to monitor emerging market debt, which represents about 80 percent of global debt. It is currently experiencing pressures with the flight of capital as a result of higher interest rates introduced in the US. Consequently, emerging countries will be forced to raise interest rates to reduce the erosion of their foreign liquidity, which will increase pressure on their economic growth and exacerbate recession risks.
A Bloomberg report indicated that the number of emerging markets with sovereign debt trading at distressed levels – yields that indicate investors believe default is a real possibility – has more than doubled in the past six months.
And “Bloomberg” reported that, in fact, $237 billion of debt is at stake for foreign bondholders, which are now in the default cycle. This adds about a fifth – or about 17 percent – of the $1.4 trillion in emerging market sovereigns that have outstanding external debt denominated in dollars, euros or yen, according to data compiled by the agency.
Reuters reported that a record number of emerging markets are facing pressure as debt sales increase. It explained that rising inflation and rising US interest rates had caused investors to flee emerging markets this year, leaving behind “a record number of developing countries” facing the possibility of default.
With currencies declining, reserves dwindling, and bond margins of 1,000 basis points, Reuters has identified a number of developing countries, including Argentina, Ecuador, Egypt, and Tunisia, which it sees as approaching the “risk zone” due to high borrowing costs, inflation and debt.
Don’t look at the returns
Sovereign bond yields in more than a dozen emerging countries are currently trading at extremely low levels, according to the Financial Times, citing Bloomberg data.
“It’s really shocking to see such a collapse in bond prices,” said Charlie Robertson, chief economist at Renaissance Capital. He added that the massive sale of bonds “is the largest in 25 years.” Investors pulled $52 billion from emerging market bonds this year, according to JPMorgan.
